Supreme Court to Decide on Severance Pay Taxes

Tax Professionals' Resource October 9, 2013 — 1,557 views

Being an employee or employer, you must be well aware of the fact that your pay is subject to withholding and income tax. What about your severance tax? Is that applicable for payroll tax too? While the Internal Revenue Service agrees with that part, not everyone is of the same opinion.

Understanding your Severance Pay

Severance pay can be defined as the gap pay that covers a period of time after the employee is done executing his services. It can be paid for a number of reasons. It can be a part of the policy of the company, which might have been put in place by the federal or state law. Other than that, it can also be paid in accordance with the agreement signed between a former employee and the company. It can either be paid willingly or as a consequence of a lawsuit.

The policy that the company follows for severance pay is important as it can leave a significant amount of tax dollars in hanging. The law that looks after severance tax is a little muddled and the IRS is pushing its plan of making it subject to payroll tax.

Around 800,000 central workers are out of work due to the recent government shutdown. According to the latest data, approximately four million people have received unemployment benefits. Out of these people, all those who got the severance package, also most probably, paid for Medicare and Social Security taxes.

Federal Insurance Contributions Act consists of Medicare tax and Social Security tax. This FICA tax is split between the employees and the employers. Out of the total pay of 12.4 percent, each one pays half the amount, that is, 6.2 percent. Medicare taxes of 2.9 percent are also withdrawn, of which both the employer and the employee pay 1.45 percent. This makes a total of 15.3 percent that is paid by both the parties cumulatively.

Battle Between Companies and the IRS

Last September, one of the central appeals court approved with Quality Stores stating that the IRS should refund the FICA severance payments, which got laid off for the workers of the bankrupt companies. Quality Stores had treated its payment as wages and had withheld employment tax, as well as federal income tax. However, the company later asked the IRS for a refund. The severance payment was ruled out by the Bankruptcy Court stating that it was not for FICA purposes.

Now, the final decision on FICA, as well as severance payments, will come from the Supreme Court. Until then the companies, as well as the IRS will have to wait.